Managing one’s retirement funds is a crucial aspect of financial planning. In recent years, self-managed super funds (SMSFs) have gained popularity among individuals seeking greater control over their retirement savings. However, many super fund members wonder if compensation payments received due to personal injury, legal settlements, or insurance claims can be contributed to an SMSF.
Below, we discuss whether you can contribute to a self-managed super fund from compensation payments and highlight some of the key considerations to keep in mind.
Compensation payments and SMSFs
If you’re wondering ‘can compensation and insurance payments be used to contribute to an SMSF’, the short answer is yes, but with certain limitations and considerations. It’s important to consult with a financial advisor, accounting or legal professional to ensure compliance with relevant laws and regulations.
Here are some of the top considerations to keep in mind:
Superannuation Contribution Caps
Compensation payments used to contribute to an SMSF typically fall under the category of non-concessional contributions (also known as after-tax super contributions) subject to annual caps. As of 1 July 2022, the non-concessional contributions cap is $110,000 per member or $330,000 using the bring-forward rule (for individuals under 67 years old). Exceeding these limits may attract additional tax liabilities.
Sole purpose test
SMSFs must adhere to the sole purpose test, which requires the fund to be maintained for the sole purpose of providing retirement benefits to members. While compensation payments may be used to contribute to an SMSF, the fund’s investments and activities must align with the sole purpose of generating retirement income.
Legal and tax implications
Compensation payments may have legal and tax implications, both before they’re paid into your super and after. It is crucial to consult with legal and tax professionals to ensure compliance with any legal obligations, including any potential impact on existing compensation arrangements, tax consequences, and any implications on means-tested benefits.
Diversification and risk management
When considering contributing compensation payments to an SMSF, it is important to maintain diversification across investments to help manage risk effectively. Over-concentration in a single asset class or investment may expose individuals to undue risk. It’s prudent to seek advice from a qualified financial advisor to develop a diversified investment strategy.
Are lump sum compensation payments better than periodic compensation payments for SMSFs?
Whether lump sum compensation payments or periodic compensation payments are better for self-managed superannuation funds (SMSFs) depends on various factors and the specific circumstances of the fund and its members.
Here are some considerations to help you understand the differences:
Lump sum payment
- – Flexibility: A lump sum payment provides immediate access to a larger amount of money, potentially allowing the SMSF to invest or utilise the funds in ways that a period payment may not.
- – Investment opportunities: With a lump sum, the SMSF may have more flexibility to pursue different investment opportunities that align with its investment goals and objectives.
- – Member preferences: Some SMSF members may prefer to receive a lump sum payment for personal financial planning purposes or to address immediate financial needs.
- – Regular income stream: Periodic compensation payments may provide a steady income stream for the SMSF, which could be helpful for meeting ongoing expenses or supporting retirement income needs.
- – Budgeting and planning: Regular payments may allow for better budgeting and planning, as the SMSF might anticipate the inflow of funds and structure its investment and expenditure strategies accordingly.
- – Risk management: Spreading compensation payments over time may help provide the opportunity to take a more cautious and measured approach to investment decisions.
What are the tax implications of contributing a compensation payment to super?
Whether you choose to make a lump sum payment or choose to receive a periodic compensation payment, different tax implications will apply. The tax treatment will depend on the nature of the compensation and the applicable tax laws. It is important to consult with a financial advisor or tax professional to understand the specific tax implications for your SMSF.
How to use your lump sum payments to purchase direct property in your SMSF
Purchasing direct property within a self-managed super fund is an opportunity that APRA-regulated funds don’t provide. A compensation payment may allow your member balances to rise to a level that supports property investment. However, unless you have sufficient funds to purchase a property outright while remaining within the allowable limits of your fund’s investment strategy, you may need to utilise some of the funds to put towards a deposit and establish a limited recourse borrowing arrangement (LRBA) to finance the purchase.
At SMSF Loan Experts, we help SMSF trustees source an appropriate LRBA for their SMSF’s unique borrowing needs.
To discuss how we can help your SMSF invest in direct property, contact our experienced team.